Harsco Corporation
Q1 2016 Earnings Call Transcript

Published: 4 May 2016

[Operator:]

Good morning. My name is Laurie, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Harsco First Quarter Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. Also this teleconference presentation and accompanying webcast made on behalf of Harsco Corporation are subject to copyright by Harsco Corporation and all rights are reserved. Harsco Corporation will be recording this teleconference. No other recordings or redistributions of this telephone conference by any other parts are permitted without the expressed written consent of Harsco Corporation. Your participation indicates your agreement. I would now like to introduce Mr. Dave Martin, Director of Investor Relations. Mr. Martin, you may begin your call.

[David S. Martin:]

Thank you, Laurie, and welcome to everyone joining us this morning. I'm Dave Martin, Director of Investor Relations for Harsco. With me today is Nick Grasberger, our President and Chief Executive Officer; as well as Pete Minan, our Senior Vice President and Chief Financial Officer. This morning, we will discuss our results for the first quarter of 2016 as well as our outlook, then we'll take your questions. Before our presentation, however, let me take care of a few administrative items. First, our Q1 earnings press release was issued this morning. A PDF file of this news release, as well as a slide presentation for this call have been posted to the IR section of our website. Secondly, this call is being recorded and webcast. A replay will be available on our website later today. Next we will make statements this morning that are considered forward-looking. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from these forward-looking statements. For a discussion of such risks and uncertainties, see the Risk Factors section in our most recent 10-K and 10-Q, as well as in our other SEC filings. The company undertakes no obligation to revise or update our forward-looking statements. Lastly on this call, we will refer to adjusted financial results that are considered non-GAAP for SEC reporting purposes. A reconciliation to U.S. GAAP results is included in our earnings release issued again today as well as our slide presentation. With that being said, I'll now turn the call to Nick for our prepared remarks.

[F. Nicholas Grasberger:]

Good morning, everyone, and thanks for joining us this morning. The first quarter developed as we expected as we're able to offset market challenges by reducing costs and improving execution. We are maintaining our full year guidance for earnings and cash flow. Our outlook for the key end markets and our performance within those markets for the balance of the year also remains unchanged. Although steel and energy prices have stabilized and improved somewhat, demand has remained weak and we see little reason to expect a change in our revenues this year compared to our original guidance. From an operational standpoint we continue to be very pleased with the performance of our Metals & Minerals business in recent quarters. We are operating at a high level of discipline, focus, organizational alignment, and precision, and we're confident our capital allocation process will lead to higher margins and returns on capital as we have seen over the past year or so. The first quarter was a case in point. M&M's adjusted operating income increased double digits versus Q1 of last year and margins were up about 150 basis points. Nonetheless, some of our customer sites within Metals & Minerals remained financially stressed and further site closures, such as the site idled in Spain during the first quarter are certainly possible. Given how dynamic the situation is, we are watching our customer sites across all geographies very closely. In terms of growth, our unique footprint in China, India, and other developing markets is also yielding attractive opportunities essentially unavailable to our major competitors. Also, our product and service capabilities provide an opportunity to grow in other markets. So although current market conditions are very weak, we still believe that the medium-to-long-term outlook for M&M is quite attractive and I applaud the team for maintaining their focus and executing. In our Rail business, the Class I railroads in North America are reducing their capital spending plans for maintenance-of-way equipment in part due to weak demand for steel and energy products. And we are working hard to offset this impact through further penetration into the international markets where opportunities remain plentiful. We're also focused on developing the initial vehicles for the Swiss National Railway later this year. We expect to recognize revenue on the project once the machines are fully commissioned in 2017. Despite this delay, initial customer feedback concerning the quality of the vehicles is very positive, and we look forward to a long and profitable relationship with this important new customer in a new geography. The pipeline for like opportunities remain strong and we are targeting such contracts in the UK, Sweden, and Germany that should be awarded later this year. In the Industrial segment, we are focused on developing and launching new products in IKG and Patterson-Kelley, and reducing production costs and developing our downstream business in Air-X-Changers. We're very encouraged by the customer response to our Hammco product line acquired a few years ago and targeted towards the downstream market. These products are growing at a strong double-digit rate this year in contrast to our legacy products oriented more towards the upstream sector. Our capacity expansion in Tulsa will be a key point of competitive advantage for both product lines as markets recover. The buzz around our new high-security fencing product reached new highs after Grateguard was recognized as the top new product for antiterrorism and force protection at a leading international trade show. This follows from the large contract we won to provide high-security fencing around the New Mexico City Airport. Our efforts to reduce debt and improve our liquidity position are yielding results. Free cash flow in Q1 was better than expected and we have improved our outlook for financial leverage and liquidity at year-end. It has been very encouraging to see how well our employees have responded to this and other key initiatives we have launched over the past year. And our focus on safety continues to result in record low numbers of recordable injuries and is increasingly recognized by our customers. So, in short, I'm very pleased with how the organization is developing in terms of alignment around our values and strategy, as well as its ability to execute. I'll now turn the call over to Pete.

[Peter Francis Minan:]

Thanks, Nick, and good morning, everyone. I'm going to start on slide four of the materials. Our reported operating income as adjusted for special items in the first quarter of $18 million was above our guidance range of $6 million to $11 million. As compared to our expectations for the quarter, results in our Metals & Minerals segment were better than anticipated due mainly to positive performance within our European and North American regions, as well as favorable weather and market conditions within our Applied Products business. In Rail, we benefited from the acceleration of certain equipment shipments that we had expected to occur in the second and third quarters. And corporate costs were lower mainly due to lower temporary labor and professional services costs and continued scrutiny of G&A. Compared to the 2015 quarter, first, it's worth highlighting that our Metals business realized an improvement in adjusted earnings and margins. We certainly didn't see any benefits from the external environment in the quarter, and thus we believe this improvement is indicative of our progress to strengthen this business. With that said, adjusted operating income for the quarter declined versus the prior year as anticipated. Lower profitability in Industrial and Rail, which as you recall included a large foreign exchange gain in the preceding year, offset the Metals impacts and lower corporate costs. Revenues in the quarter also declined as expected to $353 million, which represented a decrease of 22% year-over-year. Reduced demand for heat exchangers in Industrial accounted for the largest portion of this change. Revenues in Metals were impacted by site exits, lower steel production, foreign exchange rate changes, and weaker nickel demand. Adjusted earnings per share was $0.03 in the first quarter which was also favorable to our guidance given our operating performance and compared with the prior year quarter EPS decreased $0.17. The just completed quarter included equity income from our Brand Energy joint venture of approximately $3 million as compared with $4 million in the prior year quarter, and as in the past, both quarters included intercompany foreign exchange losses which negatively impacted our P&L. Free cash flow was a deficit in the quarter as is traditionally the case during the March quarter. Our free cash outflow was $17 million compared with $14 million outflow in the first quarter of 2015 as cash flow improvements in Metals & Minerals and at corporate were offset by free cash flow changes in Industrial and Rail. Compared to our internal plan for the first quarter, free cash flow was better than expected primarily due to tighter controls over capital spending. Also as detailed in our earnings release we recorded a few unusual items in the quarter. These items which totaled $19 million or $0.16 per share for the quarter included $3 million of cost incurred for the planned separation of Metals & Minerals, $5 million of severance costs, and an underperforming European site that was idled in which we are in the process of exiting and a $7 million adjustment net of tax related to our Brand Energy joint venture. As indicated in our press release, as permitted under our contractual arrangement we have decided to make our payments to our joint venture partner in kind as opposed to in cash for all of 2016. We see this as a prudent decision as we focus on reducing our debt and as a result we will have diluted our joint venture interest by 3% to approximately 26% by the end of the year. This net charge is essentially to write-off a proportionate amount of the book value. Moving to slide five; in the first quarter, Metals & Minerals generated adjusted operating income of $12 million (11

[Operator:]

Your first question is from Jeff Hammond from KeyBanc Capital Markets. Your line is open.

[Jeffrey D. Hammond:]

Hey, guys. Good morning.

[F. Nicholas Grasberger:]

Hi, Jeff.

[Peter Francis Minan:]

Hi, Jeff.

[Jeffrey D. Hammond:]

Just on the debt pay down, I think, before you were talking $30 million to $50 million, now you're saying $75 million to $100 million. Any other moving pieces in there besides the change from the Brand knockout and the swap?

[Peter Francis Minan:]

Yeah, those are the two biggest pieces, Jeff. This is Pete. But we've also undertaken some internal initiatives to improve our working capital in all the businesses and are starting to see the benefits of that. So, really what the rest of the year, and that change in number, Jeff, is kind of attributable largely to this initiative and we've seen the full realization of those benefits, both within working capital and outside of working capital for the remainder of the year.

[Jeffrey D. Hammond:]

Okay. And how is kind of the bias within that $95 million to $105 million of CapEx?

[Peter Francis Minan:]

We're probably on a net basis, taking into consideration, some of these initiatives down to the lower end of that.

[Jeffrey D. Hammond:]

Okay, good. Can you – I guess two questions on Metals. One, can you just talk – have you seen any real impact near-term from this more constructive steel pricing environment? And two, just as you look at site risks, can you just walk through any assessments you've done that kind of target what the potential risk could be from these additional site closures?

[F. Nicholas Grasberger:]

Yeah. I'll take that Jeff. First of all, in terms of impact of lower steel prices, we really haven't seen much left in production at our customer site. So, even though prices have firmed and that of course is reducing the risk of further site closures, the LST was still down on a like-basis, I think, 8% in the first quarter. Now we expect it to be down about 3% for the full year, so certainly improving over the course of the year, but that's been implicit in our guidance. And so, no, we haven't – we have seen nickel prices pop a little and that's providing some bit of tailwind, but they're still quite low and mostly consistent with our forecast. So with respect to high risk sites, we're spending an awful lot of time kind of analyzing the sites from that perspective and understanding what options we may have to mitigate those risks. If you look at kind of the sum of the sites that we view as high risk that they would account for less than 10% of our earnings. So while we're of course quite concerned about those sites I think it's fair to say there wouldn't be a material impact on our sales and profits going forward if they were all to close and we certainly don't expect that.

[Jeffrey D. Hammond:]

Okay, thanks. I'll get back in queue.

[Operator:]

Your next question comes from Bhupender Bohra of Jefferies. Your line is open.

[Bhupender Bohra:]

Hey, good morning guys.

[F. Nicholas Grasberger:]

Good morning.

[Peter Francis Minan:]

Hi Bhupender.

[Bhupender Bohra:]

Hey, just a question on your Industrial business here. Could you talk about, I know you spoke about the exchanger business being weak right now. If you can give some color on the Hammco acquisition which you made like a few years ago and you were trying to – you talked about like that has been a positive, a real flight within Industrials? Just give us some color on that?

[F. Nicholas Grasberger:]

Yeah. Sure. So the Hammco acquisition has far exceeded the expectations that we had when we bought the business. As you know it's oriented more towards the downstream segment of the market, which has held up quite well. And in particular given our capacity expansion at our facility in Tulsa and moving the Hammco products into that facility we now have the ability to produce much larger quantities of Hammco coolers which is largely what the customer is looking for. So we believe we're taking market share in the downstream sector of the market with Hammco and we expect revenues in Hammco to grow 30% to 50% this year.

[Bhupender Bohra:]

Okay, great, great. And just a follow-up on the Rail business, now we saw the margin kind of decline pretty steep here year-over-year because of the high equipment mix, how should we think about margins as we go through the quarters for the rest of the year?

[Peter Francis Minan:]

I think, we – hi, Bhupender, this is Pete. So, I think, we...

[Bhupender Bohra:]

Yeah.

[Peter Francis Minan:]

...the margins we're going to see are pretty much going to be slightly down for the rest of the year compared to the prior year basically attributable to the mix, but it should improve in the latter quarters from where the first quarter experience.

[Bhupender Bohra:]

Okay. So was there any one-time items where the margins was suppressed in the first quarter. You were saying we should see sequential improvement in the margins as we go through the quarters.

[Peter Francis Minan:]

Yes, that's true. And in fact, if you recall of this quarter last year, we had some pretty good margin part kits, aftermarket sales that affected the comp as well, Bhupender.

[Bhupender Bohra:]

Right. And the margin in this particular quarter was ex the $11 million gain last year, right, is that true?

[Peter Francis Minan:]

Yeah, that's correct.

[Bhupender Bohra:]

Okay, got it, I'll be in the line. Thanks.

[F. Nicholas Grasberger:]

Thank you.

[Operator:]

Your next question comes from Jeff Hammond of KeyBanc Capital Markets. Your line is open.

[Jeffrey D. Hammond:]

Hey, guys. Just a couple quick follow-ups here. So just on the Air-X-Changers, can you just talk about where you think we are in the bottoming process? What you're seeing in terms of backlog and orders kind of filling towards the back half and how that kind of informs any view into 2017?

[F. Nicholas Grasberger:]

Yeah, I think that we're still very much at the bottom. You've seen the rig count continue to decline. The rig count is now at an all-time low, since they've been tracking that metric here in North America. And as we look into our Q3 and Q4, we're not yet where we'd like to be with our order book to be honest. We're maintaining our view for the full year in Air-X-Changers, but there is risk, and there's just not a lot of activity in the upstream, and midstream sectors of the market, so we would expect there to be a healthy rebound in 2017. I think that it's really all going to come down to that rig count beginning to move up again, and it's certainly not done that.

[Peter Francis Minan:]

If you recall, Jeff, it's Pete. We also told you on the last call I think that there's some inventory in the channel. So even when the confidence is kind of locked in, in terms of the oil price, and manifest in additional rig count, it may be a little bit of a lag before we start seeing that in our order book as well.

[Jeffrey D. Hammond:]

Okay. And then just on Rail, you comment on 2017, so basically this SBB revenue uplift in 2017, we should kind of count on low no margins. Is that the right way to look at it?

[Peter Francis Minan:]

Yeah, that's correct, Jeff.

[Jeffrey D. Hammond:]

Okay. And then just last one on Metals, can you give the revenue impact from exited contracts in the quarter?

[Peter Francis Minan:]

Yeah. For the quarter, the revenue impact was $24 million.

[Jeffrey D. Hammond:]

Okay. Helpful. Thanks, guys.

[Peter Francis Minan:]

Yeah.

[Operator:]

Your next question comes from Rob Norfleet of Alembic Global Advisors. Your line is open.

[Robert F. Norfleet:]

Good morning.

[F. Nicholas Grasberger:]

Good morning.

[Robert F. Norfleet:]

Just a quick question. Can you kind of give us progress or an update on obviously the various stages at Orion? Just what the kind of run rate that we're recognizing for cost savings? And then, maybe if you could just touch on any additional cost savings initiatives that you have underway, or if there's anything really left that we can still do to improve the cost structure especially in the SG&A line?

[F. Nicholas Grasberger:]

Sure. So the total savings from Orion were about $60 million. About two-thirds of that would be head count related. The other third benefits from triage efforts and so forth. Internally, we view Orion as largely finished. We've had three waves of significant cost reduction. The process changes that we've made are now embedded in the business, including the triage process. So Orion, as we laid it out, actually two years ago on this call, is largely complete. But of course given that the changes were so dramatic in terms of process and structure, they of course remain part of the business. In terms of additional cost reduction, we're focused very heavily on reducing our cost of sales, through lower maintenance spend, more effective utilization of the equipment and driving a number of metrics to show consistent performance in operational areas across the sites. So we haven't quantified those. We're driving it very hard. We have a global head of operations, who's leading that as well as other initiatives. So it's not an amount that's, let's say, included in our guidance, but we continue to push very hard to reduce the cost of sales in M&M.

[Robert F. Norfleet:]

Okay. Thank you.

[F. Nicholas Grasberger:]

Yeah. Go ahead.

[Robert F. Norfleet:]

Go ahead.

[F. Nicholas Grasberger:]

In terms of SG&A, we certainly continue to push on SG&A. Part of the reason why the M&M results in Q1 were better than our projection was SG&A. So I think, we'll hopefully continue to see favorable variances relative to our plan for the year in SG&A.

[Robert F. Norfleet:]

Okay, great. And just my last question. I know liquidity at this point is certainly ample, relative to debt covenants, et cetera, but at this juncture are you all contemplating any asset sales in an effort to raise cash. I mean, I know obviously there are some attractive businesses within Industrial that you likely could fetch a good price for. I just want to kind of understand your thought process behind that?

[F. Nicholas Grasberger:]

Yeah, so the asset sales that we're focused on are largely within M&M. We have a number of idle assets and even perhaps some real estate that we're looking at, but really nothing of size and certainly not a business unit.

[Robert F. Norfleet:]

Okay. Thank you.

[Operator:]

We have no further questions at this time. I will turn the call back to the presenters.

[David S. Martin:]

Yeah, thank you, Laurie, and to those that participated in this call this morning. A replay of the call will be available later today through May 18, and the replay details are included in our earlier earnings press release. Lastly if you have any follow-up questions, please contact me and my contact details are included at the top of today's release. So again thank you for your interest in Harsco and have a great day.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.